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I was thinking earlier today about the effect of immigration on interest rates. In particular, I thought of an unusual argument for immigration restrictions when short-run interest rates are at the zero lower bound.

Some New Keynesian economists have suggested that destroying productive capacity can raise current output in said circumstances. (For academic journal articles asserting this, see the beginning of this paper by Johannes Wiedland, also cited below.)

The reasoning is that a negative supply shock can lower expected production, thereby increasing expected inflation. When short-term nominal interest rates are stuck at zero, this has the effect of lowering expected real interest rates. This in turn causes people to spend more money now, raising output and employment.

Intuitive example: You have money in a bank account earning nearly zero interest. A hurricane forms, threatening the supply of various goods. What do you do? Simple: you take money out of the account and buy goods whose prices you expect to go up. The opportunity cost of doing so is minimal, and buying the goods before they go up in price makes you better off.

Paul Krugman’s example of an “alien invasion”: Nobel laureate economist Paul Krugman gave an infamous example of an attack by aliens on Earth, in which governments would scramble to spend money on defense. This example is a bit different from the one I gave, because the spending is done for the purpose of fighting off a potential supply shock, rather than just reacting to one.

However, in the case of the alien invasion, there is an expected possibility of aliens doing damage to the earth, and some diversion of resources towards fighting aliens instead of producing other goods. Both of these raise inflation expectations, lower real interest rate expectations, and increase present-day spending.

What does this have to do with immigration? When the economy is at the zero lower bound, it could make sense (under the model previously described) to further restrict immigration. This reduces expectations of real GDP, thereby increasing inflation expectations and inducing more spending.

Indeed, some people have referred to the existence of an “illegal alien invasion” (Google the term for examples); namely, of people entering the United States unlawfully. (Put aside the question of whether it is accurate to call mostly-peaceful migration an “invasion”.) But, unlike Krugman’s, this “alien invasion” would lower current output! With more immigrants adding to future real GDP, and short-term nominal interest rates stuck at zero, people would expect that goods will be cheaper in the future than they previously thought, and would hoard more money as a response.

A few reasons why I don’t actually endorse this argument for immigration restrictions:

Even accepting the described view on supply shocks, one might not want to trade off future production for present production. Krugman was joking with his suggestion of faking an alien invasion, and it’s unfair to say that people who endorse this model don’t care about the long term at all.

There are empirical issues with the claim that negative supply shocks at the zero lower bound are expansionary. Johannes Wieland of UC Berkeley argues in the previously linked paper “Are Negative Supply Shocks Expansionary at the Zero Lower Bound?” that “financial frictions” prevent this effect from working. He claims that negative supply shocks reduce the value of banks’ balance sheets, thereby constraining their lending and preventing the positive effect on aggregate demand from taking place. Using a general equilibrium model with these “financial frictions” built in, he finds that negative supply shocks at the zero lower bound do hurt short-run output. More research here may be needed, but his case seems plausible.

There are better ways of dealing with the zero lower bound. I don’t want to get into my views on monetary policy here, but it should suffice to say that most people across the various schools of thought find there to be better ways of getting out of the zero lower bound than deliberately destroying productive capacity.

Immigration could raise returns on capital and investment demand, thereby raising interest rates. Generally speaking, expanding the supply of labor is expected to raise the return on capital by acting as a complementary good. However, I say “could”, because the complementarity between labor and capital is very complex, and there are cases in which immigrants act as substitutes for capital. Dartmouth economist Ethan Lewis has done some work on this subject; see, for instance, “Immigration and Production Technology”.

I can’t say I find the “restrict immigration more at the zero lower bound” argument persuasive, but it is at least interesting, and I think I am the first to suggest it.

Very often, people seem to confuse Say’s Law (or the closely related Walras’ Law) for the proposition that nominal spending doesn’t matter, or that aggregate demand shortfalls and excesses cannot occur. As I shall demonstrate, however, its clear implication is the opposite when one considers the case of money as a tradable good.

Imagine an economy in which money and goods are exchanged for each other. (Multiple different types of money can exist, although this does not change the outcome.) Many of the trades made involve money being traded for other goods. However, money is still “supplied” and “demanded” in the same sense that any other good is, and has a “price” in terms of other goods. Thus, there exist states of monetary equilibrium and disequilibrium.

Monetary disequilibrium exists when, at a given real value of the monetary unit, the the real quantity of money the public demands to hold (and is willing to purchase by selling other goods to obtain money) is not equal to the real quantity of money actually provided. As Walras’ Law implies, a shortage or surplus of money is matched by a surplus or shortage (respectively) in all other goods collectively, as measured by the market value of said surpluses and shortages.

So what, then, does monetary disequilibrium imply in terms of nominal spending? When a surplus of money is held (in real terms), there exists a shortage of other goods to be bought with money, and the public seeks to reduce its real holdings of money by increasing nominal spending of held money on goods. Such a situation is that of an excess of aggregate demand.

Conversely, when a shortage of money is held (in real terms), there exists a surplus of other goods to be bought with money, and the public seeks to increase its real holdings of money by decreasing nominal spending of held money on goods. Such a situation is that of an aggregate demand shortfall.

Walras’ and Say’s Laws concern themselves with markets in equilibrium and disequilibrium, and the fact that a shortage of good A in terms of some other good B it is traded for implies that there also exists a surplus of the good B in terms of good A. One need not reject this insight to accommodate the empirical existence of shortfalls and excesses of nominal spending. One must only consider what it is that is actually being spent.